Is There Anything Better Than an IRA?
Retirement savings are crucial, and an IRA offers tax advantages when saving for it. Make the maximum annual contribution, using an online robo-advisor to build an investment portfolio to suit your goals.
An Individual Retirement Account, or IRA, offers more investment flexibility than many workplace plans; just be sure to inquire about its fees beforehand.
Tax-Advantaged Savings
Tax-advantaged accounts like IRAs, 401(k)s, 529s and Coverdell ESAs allow individuals to save for specific goals or expenses such as retirement, education costs or helping a disabled family member. Your contributions and any earnings are protected from ordinary income taxes until withdrawal or reaching age 59 1/2, so your funds remain tax-free until then.
But not all tax-advantaged savings and investment accounts are equal; making the right decision depends on your unique circumstances and financial situation. Contribution limits and withdrawal rules of individual retirement accounts (IRAs) differ significantly from employer sponsored plans or other tax-advantaged accounts; additionally, investment options vary with some offering more choices than others. Here is an overview of various types of tax-advantaged savings accounts and their respective pros and cons.
Tax-Free Withdrawals
An Individual Retirement Account (IRA) allows you to save pretax, and only pay taxes upon withdrawal of funds. Withdrawals are taxed as ordinary income unless used for specific purposes such as purchasing your first home, paying higher education expenses such as tuition fees or unreimbursed medical costs which exceed 7.5% of adjusted gross income.
You may withdraw money penalty-free from an IRA if you are either the beneficiary of someone who has passed away, or are taking substantially equal periodic payments over a set period. Otherwise, an early-withdrawal penalty of 10% must be paid; and any distribution will incur regular income tax liability.
Investment Flexibility
While a savings account can offer some stability, its meager interest rates make it all too easy to fritter away your savings. A Roth IRA’s growth potential can be much higher.
Mutual funds typically adhere to one style box, but flexible mandate funds allow managers the freedom to follow their best ideas. A simulation model of large-cap stocks showed that managers using such flexible mandate funds outshone traditional equal weighted portfolios by 0.9% annually.
If your employer offers matching funds, be sure to maximize collecting them in your 401(k). Otherwise, review what investments are available both inside and outside your 401(k), before considering which option has lower costs overall.
Tax-Deductibility
Contributions you make to an IRA are tax deductible in the year of their contribution, thereby lowering both current income and taxes owed. This above-the-line deduction can be claimed regardless of whether or not itemizing deductions is taken advantage of.
To qualify for this deduction, both you and your spouse (if filing jointly) must receive taxable compensation, such as wages, salaries, commissions, tips bonuses and net earnings from self-employment. Employee benefits such as health, life and disability insurance don’t count towards this total.
But if you take distributions before age 59 1/2, they’ll incur a 10% early withdrawal penalty and tax due at your current tax rate on any money withdrawn. To avoid this penalty altogether and save taxes at your current rate on any distributions made before that age threshold has passed, making qualified charitable distributions can help protect against this fateful scenario.
Investment Options
Occupants who meet income limits may save both in an IRA and workplace savings accounts (depending on annual limits), however the best savings vehicle for you depends on your financial goals and priorities. If your employer offers a 401(k) match, prioritize this first.
IRAs typically offer more investment options, including stocks, bonds, mutual funds, and exchange-traded funds. These could provide higher returns than savings accounts but without as much risk exposure; however, take note that increased potential for return may come at the cost of reduced liquidity – meaning you may not always have quick and easy access to your money as with a high yield savings account.
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